Views – April 2017

Earnings Earnings Earnings !

One of the busiest and most interesting times for analysts is the reporting season. There are primarily two times in a year (four times in the US) where Australian companies report their most up to date earnings and forecast for the year ahead. While it is true that the sharemarket overall shows a certain degree of volatility on a daily basis, it is during the reporting periods where we tend to see some of our largest individual stock swings according to whether their reports are better or worse than expected.

With Australian companies having just completed their earnings report and provided guidance to the market on their outlook for the year ahead, we thought this is a good opportunity to step away from the macro-economic news that has dominated the headlines especially since Brexit and the Trump presidential win.

How do we compare front page news and earnings news?

We often discuss the macro-economic environment with our clients and, to cut a long story short, every single person in the meeting usually has a view. Everyone has an opinion based on how they interpret the information from the media. And each view is neither right nor wrong. We could debate about certain political or economic topics all day and, while interesting, may not produce any conclusion. While it’s important to understand and discuss important macro-economic issues and policy decisions, much of what is in the media is usually nothing more than noise. Sorting between the important issues and the noise can be very difficult and hence the ongoing debate.

Therefore, we again stress the point of looking at your share holdings as individual businesses. It is hard enough to try and consider each company’s position in light of their expected earnings pattern on their products and services, let alone trying to determine whether their share price will be up or down or sideways tomorrow, the next day, or the next week or month.

Being human, it is never easy to stay away from the lure of the crowd when a typical market participant’s decision is often heavily influenced by the actions and discussions with friends and relatives, often at social gatherings. However, this sort of decision making takes away from the very basis of what investing is all about.

At its core, the sharemarket is there for the opportunity to invest in businesses. When a business earns a profit and then earns even more the next year and the year after, it generally increases the value of that business (and therefore the share price as well). This is how you would look at a business if you were to purchase it in its entirety. The charts below show just how closely correlated the earnings pattern and share price of Invesco and Apple are over the long run. In the near term, macro-economic noise may push their prices below or above the trajectory of their earnings, but over the long run, it follows a very similar path.